Is Social Security a Ponzi Scheme?

Matt Yglesias says anyone who thinks social security is a Ponzi scheme is nuts. So let’s take a look at some of these nuts. First up is Nobel prize winner Paul Samuelson who wrote:

Social Security is a Ponzi Scheme that Works

The beauty of social insurance is that it is actuarially unsound. Everyone who reaches retirement age is given benefit privileges that far exceed anything he has paid in — exceed his payments by more than ten times (or five times counting employer payments)!

How is it possible? It stems from the fact that the national product is growing at a compound interest rate and can be expected to do so for as far ahead as the eye cannot see. Always there are more youths than old folks in a growing population. More important, with real income going up at 3% per year, the taxable base on which benefits rest is always much greater than the taxes paid historically by the generation now retired.

…A growing nation is the greatest Ponzi game ever contrived.

Samuelson wrote that in 1967 riffing off his classic paper of 1958. By “as far as the eye cannot see” he apparently meant not very far because it soon became clear that the system could not count on waves of youths or rapid productivity growth to generate the actuarially unsound returns that made the program so popular in the early years.

Milton Friedman and Paul Samuelson rarely agreed on much but Friedman also called social security a Ponzi scheme. In fact, he called it The Biggest Ponzi Scheme on Earth but perhaps Yglesias puts Friedman in the nut category so let’s go for a third Nobel prize winner who recognizes the Ponzi like nature of social security, none other than…..Paul Krugman (writing in 1996):

Social Security is structured from the point of view of the recipients as if it were an ordinary retirement plan: what you get out depends on what you put in. So it does not look like a redistributionist scheme. In practice it has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today’s young may well get less than they put in). (ital added, AT)

Of these, I agree the most with Krugman. Social Security is not necessarily a Ponzi scheme but it only generated massive returns in the past because of its Ponzi-like aspects. The Ponzi-like aspects are now over and social security is turning into what is essentially a forced savings/welfare program with, as Krugman recognizes, crummyreturns for average workers. Social security is thus a Ponzi scheme which has not gone bust but it has gone flat.

We can riff on definitions of Ponzi all you want, but with a loose definition of Ponzi you could call any agricultural cooperative a ponzi scheme–there are initial investors who establish the business, and are returned capital at the end of their retirement, meanwhile using the coop to serve their needs during their term of their membership.

With a loose definition of ponzi scheme, you could call a mutual insurance company and a credit union a ponzi scheme also.

But, none of these are, including SS.

Go to oyc.yale.edu and look up Shiller’s finance course. Look through the syllabus and download the lectures on social security and social insurance if you want to learn something, because you sure aren’t going to learn anything from this post and the likely comments that follow.

ColinSeptember 10, 2011 at 1:30 pm

Nice red herring Bill. I read the transcript of Schiller’s lecture (actually about 1/3 of a lecture, the rest was on bankruptcy) on Social Security. It was a nice, brief, history of the German foundations of Social Security, with only the briefest, en-passant discussion of the economic aspects of the system.

That said, in response to you, let’s rephrase:
Social Security, in its present manifestation, approximates a ponzi scheme, due to faulty assumptions of demography and political economy. Simplified for sound bites: It’s a ponzi scheme.

Could you show us this “more”? I know it’s suspenseful to see if we can find it or not, but if you come right out and explain what you want us to discover, we’re much more likely to understand and maybe even agree with your belief.

BillSeptember 10, 2011 at 3:02 pm

Collin,

Here are some more parts of Schillers course on finance re social security:

If you go through some of the other transcripts and programs, you’ll run across one which also discusses social insurance from a risk management perspective (I don’t have the time to find it, so take the course online): basically, if, before you were born, your parents (before they knew your health condition) could purchase insurance to, say, cover your health for life, the terms of which would be x% of your salary over a liftetime, and all other parents would be making the same choice, the premia would be extremely low: why: the law of large numbers, the absence of adverse selection (people later chosing insurance because they had private information about their health). Writing a policy on this pool would be very very riskless–you would know out of this pool, there would be x cancer cases, x heart attacks, etc. and there would be low variance. (The same is true for annuities and the law of large numbers, as death and disability across large pools are pretty predictable if everyone is in the pool). social insurance is the product that reduces that variance and makes the lowest cost product available.

John ThackerSeptember 10, 2011 at 4:06 pm

Yes, and all that is fine, but the thing that makes Social Security dishonest is that the currently promised returns are not in actuarial balance, and are scheduled to be cut by 20% when the Trust Fund runs out.

It’s possible for Social Security to not be a Ponzi scheme, but it’s been promising returns for years– and still promises them, though some papers admit that they’ll be cut suddenly– that can only be achieved by making it a Ponzi scheme.

BillSeptember 10, 2011 at 4:55 pm

John, As you know, slight adjustments–adjusting cola and raising the cap slightly–brings it to actuarial balance. But, as others would tell you, no one plans 75 years out.

Now, if it were a private annuity, which I paid in over my lifetime beginning at 18 and ending at 65, it would have been just my luck to pick AIG.

tomSeptember 10, 2011 at 10:25 pm

None of this remotely resembles Social Security. There are two reasons health insurance premiums would be low in the above example, first is that healthy people vastly outnumber unhealthy people and second the rates of illness in general should hold steady or decrease as they represent negatives that individuals seek to avoid. If the heart attack rate were to spike up one expects it to drop as the causes are investigated and actions taken by people that don’t want to die (ie almost everyone).

Social Security on the other hand is primarily “retirement insurance” in its current form, and this does not resemble health insurance in anyway. First individuals strive to live longer lives and billions are poured into research into helping the extension of life. Secondly the ratio of retired individuals to working individuals is much higher than than the ratio of unhealthy people to healthy people, which implies vastly higher premiums from the outset.

Of course theoretical discussion isn’t needed. It is simple historical fact that SS has never taken in enough money to cover its promises. The retirement age has been pushed higher multiple times and the contribution rates have skyrocketed to cover these shortfalls. These adjustments have not been ‘slight’ in any sense. Contribution rates were raised to 4% in 1956 and are now 13% DESPITE the fact that the tax base is also greatly higher than it was in 1956 in both individuals and average wages.

BillSeptember 10, 2011 at 10:59 pm

tom, An annuity does, as does disability, apply to the elements of social insurance that I outlined above: the law of large numbers and the elimination of adverse selection.

Look at it this way: let’s say you are 30 or 40, and there is no SS; you come to me as an insurer and say: sell me an annuity and some disability insurance to last my lifetime. As the insurer, I do not know your true state: healthy or disguised unwell. So, I write or do not write accordingly, but add a premium because you came to me, and I do not know your true state. Moreover, assume another scenario: before 40, you became disabled, without insurance: now, you go on public welfare, and I pay for you, rather than you paying through social insurance from 18 forward as a mandated contribution. ,

Colin, I am waiting for any lectures you have. I gave you three. What do you have?

Ron PotatoSeptember 10, 2011 at 8:02 pm

Yeah, lectures are awesome! You’re so smart Bill.

BillSeptember 10, 2011 at 9:33 pm

Ron, What do you have to offer? Anyone you can offer up as a lecturer on the subject?

AmeetSeptember 12, 2011 at 11:31 am

A lecture is content delivered in a certain format. An article or book can deliver the same content too, but uses a different format. Hence, to proclaim that you have provided three lectures is meaningless – three lectures do not trump the writings of three economists just because they are in lecture format versus books or articles.

BillSeptember 12, 2011 at 10:02 pm

Ameet, OK, the why don’t you read a book like Orzag’s? It doesn’t take your position. You want more material__go to the Brookings Institution studies on SS.

Lectures given to Yale students are the most mundane and middle of the road thing you can offer anyone.

You stand at the fringe.

John ThackerSeptember 10, 2011 at 2:40 pm

We can riff on definitions of Ponzi all you want

Bill, in my opinion it is Yglesias who is riffing on the definition of Ponzi scheme and defining it in an odd way so as to exclude Social Security.

Social Security promises acturially impossible returns, as Samuelson said. That’s what makes it a Ponzi scheme– the promised returns are unsound, and made up for by having an ever increasing number of members.

That Social Security can be made sound by slashing benefits to an actuarially sound level doesn’t change that it’s currently unsound. All Ponzi schemes can be made sound by slashing promised returns of later participants to less than zero. Of course, people would stop voluntarily signing up in that case. Social Security doesn’t have that problem because it’s a legal requirement, but I don’t think that’s really a good argument– it’s just a scheme with mobsters who can enforce it.

With a loose definition of ponzi scheme, you could call a mutual insurance company and a credit union a ponzi scheme also.

the promised returns are unsound, and made up for by having an ever increasing number of members.

And they always have been, which is why the tax keeps going up.

Outside of government, this would result in such a scheme going bankrupt and the later investors getting nothing as too many people flee the Ponzi scheme to sustain payments. But the government forces everyone to keep paying, backed by their monopoly on the use of force and the wishes of the electorate, so instead it goes (as Tyler says) flat — later investors are still getting screwed, but they have no choice, they can’t leave and are forced to accept a subpar return.

BillSeptember 10, 2011 at 5:09 pm

John, I know you are smarter than this. But tell me, did the first recipient of SS, your grandfather, fully pay in? Of course not, so it was not actuarially balanced at that time, nor was it inteded to be, as it couldn’t be. But, it doesn’t matter. We all are paying for our first grandparents SS and medicare as well, as will my son. So what. The point is that this social insurance gives you something, and with small changes, will give you and your children the same benefits you both expect. You might want to go to the Shiller lectures and the lecture by another Yale prof that I cited above.

AnonSeptember 10, 2011 at 6:40 pm

Bill, stop being an ass. You’re smarter than this.

BillSeptember 10, 2011 at 7:24 pm

Anon, evidently when I offer support for my position it disturbs you so much that all you can do is name calling.

Ron PotatoSeptember 10, 2011 at 8:03 pm

You are hand-waving in the manner of scholasticism. I am hand-waving in the direction of your ass.

BillSeptember 10, 2011 at 11:00 pm

Bill, I accept the criticism of being scholastic.

NateSeptember 11, 2011 at 12:55 am

Wait, you admit that it’s actuarially unbalanced, but claim that with small changes, it could be prolonged effectively indefinitely? Described this way, it doesn’t sound much like something a normal person would start to invest their money in if they had a choice. I know I wouldn’t.

BillSeptember 11, 2011 at 11:01 am

Nate, Think of it this way: your parents decided for you before you were born, not knowing whether you would be disabled, injured when you were young or older, and signed you up for an annuity that was pay as you go–paying for them as they retired, and for you as you retired–and collecting over a lifetime, rather than a 55 when you panic and realize that you can’t get an annuity, its too expensive now (gosh, if I had only saved when I was 18-21). And, besides, there are many free riders out there–people who never save–maybe you are one–and I would have to pay for you rather than see you in poverty. So, I like it when those free riders, maybe you, have to pay thorughout their lifetime. SS is not a ponzi, and it protects me from free riders who never wanted to save unless you forced them.

NateSeptember 11, 2011 at 1:15 pm

Describing Social Security as an annuity that my parents decided to enroll me in is disingenuous; they didn’t decide anything and I didn’t decide anything—because the system is compulsory. If my parents had wanted out, they couldn’t get out, and now that I want out, I can’t get out! This doesn’t sounds like any kind of annuity I’ve ever heard of.

And you’re making a great deal of assumptions about me and my life. What makes you assume that I won’t save a penny until I’m 55, at which point I’ll panic and demand that other people take care of me? I am actually very young but I have significant savings and investments. I’m not at all the kind of person who needs to be forced to save. How does Social Security protect me from people who don’t do the same? It seems to me that my financial future is much more determined by things like market returns and asset allocation than what ignorant people do or fail to do.

Gene CallahanSeptember 10, 2011 at 3:02 pm

“A true Ponzi scheme never plans on giving you paid for.”

False. Ponzi schemes imply that *many* investors will not get back what they paid in. But funds from later investors are *often* used to provide returns to earlier ones. For one thing, it keeps the authorities away, and secondly it generates good word of mouth. (“Gene got me a 200% return last year!”)

AnonSeptember 10, 2011 at 6:49 pm

Furthermore, every Ponzi scheme does promise big or consistent returns.

BillSeptember 10, 2011 at 8:35 pm

So does a corporate bond, but that is not a ponzi scheme.

B is a subset of A. B intersects C. C does not have to be A.

lemmy cautionSeptember 10, 2011 at 8:44 pm

The original ponzi scheme crashed after 200 days leaving the later investors nothing. Social security will be around for a long time.

NateSeptember 11, 2011 at 12:58 am

…because it’s compulsory! If Charles Ponzi has been able to force new people to invest in his scheme at gunpoint, and force current investors to continuously pay more to support the ever-growing poor of recipients, that would have lasted a lot longer, too!

Andrew'September 12, 2011 at 9:48 am

Just to pile on, Ponzi schemes pay out until the cannot, not because they don’t plan to. That’s not part of the definition. A pyramid is a structure, not a motive.

ColinSeptember 10, 2011 at 1:11 pm

“A Ponzi scheme is a fraud where in the end the whole pyramid goes bust a bunch of people wind up with no money at all. The absolute only reason Social Security could ever go bust like that would be if elected officials decided they wanted to stop paying benefits.” –Yglesias

This is stupid. Social Security is not a fraud since it’s been made legal by acts of Congress. It can’t go bust since Congress can arbitrarily inflate the currency, maintaining the appearance of paying benefits. However, in the end, “a bunch of people wind up with no money at all”. OK, not “no money”, but Lim(x->0) $(x), which is approximately the same.

eric falkensteinSeptember 10, 2011 at 1:14 pm

In a Ponzi scheme, fund withdrawals are not covered by investments, rather, new investors. Social Security assets are simply IOUs from the Treasury, as new money is just added to general revenue (unlike Canada, and many state employee retirement programs). The present value of current SS obligations over projected revenues is about $20 B, and off-budget. If a private firm did this, it would be against the law, and its owners put it jail. I think this is clearly a Ponzi scheme, and I think this point is a winner for Perry, because its true.

StanfoSeptember 10, 2011 at 1:16 pm

I don’t like Mr. Perry, but criticizing him for seeing the same qualities that Krugman, Friedman, Samuelson, or any economist worth his salt sees in SS is dishonest.

He’s no academic, and he surely doesn’t know how to articulate his views very well.

I used to think the idea of a liberal media with it’s own agenda was crazy, but maybe not….

Speaking of “crummy returns” – here’s a tool that can estimate them for you based on when you were born, your expected average lifetime income, and the type of household in which you live (single male, single female, one earner couple, two earner couple.)

MikeSeptember 10, 2011 at 1:55 pm

Great calculator. Although it’s just an estimate, everyone ought to understand that SS is nothing but a redistribution plan. If your rate of return is less than your required ROR, then it is not a savings plan, it’s a dissaving plan. It’s not insurance, it’s disinsurance.

Mike, before you were born, you parents did not know, nor did you, your income stream, and that’s why they made this choice for you and for themselves. Ex ante always looks different. If you are wealthy like me, you get income tax deferral and other benefits through your 401k.

MikeSeptember 11, 2011 at 12:22 am

Must be nice not to actually need SS or the 12.4% of your income you surrender for it.

I’m thinking about what I could have done with that money.

My grandparents came to this country with nothing but the clothes on their backs and started businesses. They didn’t come here for this country’s wonderful retirement plan or health care system, Bill.

Would you care to know why they came here? That is the America I’m trying to protect.

BillSeptember 11, 2011 at 9:03 am

Mike, You assume a world in which, had you had the same money, you would not have had to buy an annuity or disability insurance over your lifetime, or a world in which an elderly poor person, who did not pay in during his working lifetime (and could have paid in) would be allowed to live in a homeless shelter, which, by the way, you would have paid for in your taxes. Compulsory means the poor pay, even if they do not want to, for their retirement.

Andrew'September 12, 2011 at 10:02 am

Bill,

Only 50.1% of people make a decision that binds everyone in a democracy, and that’s not even true when you consider costs of action and information.

BillSeptember 12, 2011 at 10:03 pm

Would you like a dictatorship instead or rule of the minority?

bxgSeptember 10, 2011 at 1:20 pm

> Social Security assets are simply IOUs from the treasury

spencerSeptember 10, 2011 at 1:21 pm

The returns on social security depend heavily on your income level..

If you are in a very low income your returns on social security are very high..

But if you are in a high income bracket and especially if you have to pay taxes on your social security income because you have other sources of income your returns are very low.

But is your statement that the returns to a middle income individual are very low actually correct?
What is your source behind that statement and what does that source use as an alternative investment. If it is stocks, does it assume an average return every year or does it include the risk that you might encounter a period late in life –say from age 50 to 70 — that stock market returns are negligible. The odds of this are actually very high.

Philemon LoySeptember 10, 2011 at 10:29 pm

If you are in a very low income, it is much less likely that you will live long enough to collect anything. At the very least, it is more likely that you will die earlier than the fella in the high income bracket and hence collect less than he will…

John BaileySeptember 10, 2011 at 1:21 pm

It hasn`t gone bust, yet…

The baby boom, specifically me, have just begin to retire and
the Federal deficit is already 10% of GDP.

How much longer can that last?

Brian JSeptember 10, 2011 at 1:23 pm

It’s only a Ponzi scheme if you change the definition of what a Ponzi scheme is. Here’s one description, from Wikipedia:

The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.

I don’t think there’s any fraud here. The government isn’t promising returns like one of those late night television commercials.

We have a relatively clear idea of how the costs are going to go up; surely you’ve seen the graphs that level off after a certain point. And while small changes in the assumptions about, say, immigration can make a fairly big difference, you can more or less plan for that. We’re not suffering from a lack of ability to model.

There’s a legitimate question of how to handle the costs–what, if anything, to cut, or what to tax. But in the end, it’s a matter of arithmetic. The questions of how to change the program to get people a better return and giving them more choice to plan how they see fit for their own retirements are questions of efficiency and liberty. (That last part sounds kind of dramatic, but I think you get the idea.)

Unless these people who are saying it’s a Ponzi scheme are being sarcastically glib, they are being kind of nutty.

GinSlingerSeptember 10, 2011 at 1:32 pm

“The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent. ”

I believe SS payments are promised to be unusually consistent, or did I miss the crash in benefits corresponding to 2007?

John ThackerSeptember 10, 2011 at 2:46 pm

And don’t forget that by law Social Security payments are never allowed to decrease, even if there’s deflation or a fall in the general wage rate.

MikeSeptember 10, 2011 at 2:02 pm

Dont confuse common characteristics of Ponzi Schemes with its definition.

The definition is a scheme where the only source of paying early investors is the investments of later participants. SS is a Ponzi Scheme. The duration of the scheme’s solvency or the methods by which it raises funds are immaterial. It has gained notoriety because of their propensity to fail and the fraudulent methods of raising capital.

BillSeptember 10, 2011 at 3:04 pm

By that definition, so are ag coops, mutual insurance and credit unions. They depend on new entrants and savers and withdrawers.

John ThackerSeptember 10, 2011 at 4:10 pm

Yes, so that’s a bad definition. However, a good definition would note that the scheme promises impossible returns that have to be made up for by using the capital of later entrants.

A mutual insurance company is not a Ponzi scheme because it’s in actuarial balance. If it’s not, then it’s a fraud. Social Security could be in actuarial balance, but it’s not. That has nothing to do with Congress spending the Trust Fund– after the Trust Fund runs out, it will take a sudden 20% cut in benefits, or a big tax hike, or some combination, in order to put it in balance.

It’s the promised impossible returns that make it a fraud.

MikeSeptember 11, 2011 at 12:30 am

I don’t know anything about Ag coops, but mutual insurance companies and credit unions do not rely on new entrants. CUs earn fee income and interest margin. Insurance companies have investment income. Ponzi schemes have zero investment returns. The returns paid to early subscribers come from later investors.

You’re wrong. Ag Coops, Mutual Insurance and Credit Unions use the money deposited in them for investment. Credit Unions have loans (which link to a material asset that can be seized for non-payment), Ag Coops do the same for farm equipment and animals, and mutual insurance invests money into stocks and bonds.

Social Security ONLY has magical treasury bonds that can’t be sold to other investors. They are just paper IOUs from the general fund to be paid back “later”.

BillSeptember 12, 2011 at 10:06 pm

Xmas, Go to Shiller’s lectures and listen to the lectures on mutual insurance. Insurance is a steady state matter with reserves–premiums coming in, payments going out. Coop members put in capital, use the coop, get the capital back out without interest when they retire from farming, and new members replace them.

John ThackerSeptember 10, 2011 at 2:45 pm

The Ponzi scheme usually entices new investors by offering returns other investments cannot guarantee, in the form of short-term returns that are either abnormally high or unusually consistent.

Social Security offers returns that other, actuarially sound investments cannot guarantee. Its promised returns are an impossible combination of abnormally high and unusually consistent.

The perpetuation of the returns that a Ponzi scheme advertises and pays requires an ever-increasing flow of money from investors to keep the scheme going.

This is also true of Social Security.

I don’t think there’s any fraud here. The government isn’t promising returns like one of those late night television commercials.

They’re promising impossible returns. What they’re promising has to be cut 20% in order to bring it into balance. Sure, they’re not promising as extreme returns as the worst frauds, but that’s an very different statement from saying that there’s no fraud.

Brian J, I think you’re being kind of nutty. You’re offering evidence that it’s a Ponzi scheme, then denying that fraud exists because the promised returns are only 25% higher than what’s possible, instead of 100% higher.

John ThackerSeptember 10, 2011 at 3:01 pm

I don’t think there’s any fraud here. The government isn’t promising returns like one of those late night television commercials.

For my edification, exactly how high a level of impossible returns must be promised to go from “no fraud” to “fraud?” 25% too high impossible returns are “no fraud” in your book, I see.

EdSeptember 10, 2011 at 1:33 pm

Social security becomes much less attactive if the economy simply stops growing for a long period of time,but then that’s true for just about any investment vehicle.

John ThackerSeptember 10, 2011 at 2:48 pm

Yes. That’s not the problem. The problem is that it’s not balanced. It promised impossible returns, obtainable only by taking from future contributors. In order to meet the promised benefits it requires continually increasing the tax rate, or eventually slashing the promised benefits/benefit formula. (You could imagine raising the tax rate once only if you alter the benefit formula based on payments put in, which would be another way of slashing benefits.)

That’s what makes it a Ponzi scheme, even by the view of an admirer like Samuelson.

8September 10, 2011 at 1:38 pm

SS is a ponzi scheme because it was sold to the American people as an investment. Go read any message board, talk to relatives or listen to the confused Tea Partiers who say things such as “Get your government hands off my Medicare!”, who also will say Obama is destroying SS and they deserve to get back the money they paid in. If you look at what the average American thinks SS is, an investment they pay into and then receive their own money back, it’s about as much of a fraud as a ponzi, in the sense of duping the public. That’s a big reason why it’s a third rail and cannot be reformed. If people learn it’s straight up wealth redistribution, they could more easily understand the numbers are now bad and there needs to be a shift to keep it sustainable. But then they might get pissed about those payroll tax cuts…especially since SS is already in the red right now, with negative cash flows.

John ThackerSeptember 10, 2011 at 2:50 pm

the confused Tea Partiers who say things such as “Get your government hands off my Medicare!”

In my reading of the Internet and talking to relatives and people, I am 100% convinced that this statement and its like have been said much more often by people using at as example of silly Tea Partiers than it has ever been said by Tea Partiers.

Of course Medicare and Social Security are quite popular, so they are fairly popular among Tea Partiers as well. At the same time, Tea Partiers are the most willing of any Americans to cut Medicare and Social Security, according to the same polls.

I thought that Ponzi schemes required that the persons contributing to it not understand how the wealth was generated, such as Madoff. If the participants knew, then they would probably be out in an instant for fear of legal ramifications. In social security, all citizens can find out how it works, albeit with some legal complexity. However, it’s still possible, and the fact that we are even talking about it’s structure and history show it doesn’t fit that rule. So I think it depends on how you define Ponzi scheme and how many restrictions you put on it.

NormanSeptember 10, 2011 at 2:45 pm

“If the participants knew, then they would probably be out in an instant for fear of legal ramifications.”

You don’t think many participants currently paying in would be out of SS in an instant if we had a choice? SS doesn’t have to keep its methods a secret because the police power of the state prevents the kind of flight you refer to. That just makes it a Ponzi scheme enforced by the gun.

vorpalSeptember 10, 2011 at 3:47 pm

See, nuts, just like Yglesiasis said.

John ThackerSeptember 10, 2011 at 4:13 pm

You’re arguing that the claim that the government will prosecute you if you refused to contribute to Social Security is nuts?

Wow, you’re nuts, vorpal. Tax protestors are nuts, but people who argue that the government doesn’t arrest tax protestors are also nuts. You’re the latter. Either that, or you’re the kind of nut who thinks that Social Security is voluntary.

vorpalSeptember 10, 2011 at 4:26 pm

No John, I’m saying that people that can’t wrap their head around taxes as a part of civilised life in are severely emotionally unbalanced, especially in a country where the taxes are relatively low compared to virtually any other similar nation. US is not medieval Nottingham County, but it sure does have it’s share of weird Robin Hood wanna-bes.

NormanSeptember 11, 2011 at 4:30 am

For the record, my problem is with the promised benefits only being deliverable by sufficiently large growth in the taxable labor force, not the tax itself. It’s the fact that the promises are designed to make pay-as-you-go look like an actual investment prospect that makes it a Ponzi scheme.

If SS were actually treated as a tax and the government made plain that current payments into the system have no real connection to what you’ll actually receive, it would just be a redistribution program. I’d be fine if SS would ditch the ‘Ponzi game aspect,’ as Krugman put it. And eventually it’s going to have to.

AnthonySeptember 10, 2011 at 1:45 pm

The fundamental aspect of a Ponzi scheme is that earlier investors are paid from the payments of later investors, and is thus mathematically unsustainable. That, in a nutshell, exactly describes Social Security. Anyone who thinks Social Security is *not* a Ponzi scheme is an economics-denier.

Gibbon1September 10, 2011 at 5:58 pm

The big hole in your argument is Social Security isn’t an investment vehicle it’s an insurance one. There are no investors, no investment at all other than the trust fund and social security doesn’t promise in general any over all return on the money contributed. Given that it’s simply not a Ponzi scheme by simple exclusion.

A Ponzi scheme promises that the money contributed will be invested, but no actual investment takes place. Social Security is transparent in that money contributed is paid out and some of it is held in reserve in the form of the trust fund. In return the contributor gets an entitlement, worth some percentage of future workers FICA contributions.

In short no investment means it’s not a Ponzi Scheme by definition, end of story. Anyone claiming otherwise is taking a conclusion they want to believe and then cherry picking evidence to support their conclusions. Personally I’d be embarrassed to make such arguments because they are so lame an weak.

AnthonySeptember 10, 2011 at 6:34 pm

“social security doesn’t promise in general any over all return on the money contributed.”

Nether do many Ponzi schemes or legitimate investment vehicles. Social Security benefits are, like most other defined-benefit pension plans, based on the individual’s contributions.

Social Security is only “insurance” only in the same sense that whole-life insurance is insurance – if certain adverse events occur, your payout is changed; however, if you live without being disabled and retire at 65, your payout is purely a function of what you paid in.

John TSeptember 10, 2011 at 1:54 pm

Could we get a formal definition of ponzi scheme and pyramid scheme? Seems these are “hot button” terms with some variance in definition which makes this discussion hard to keep reasonable,un-emotional, etc.

MikeSeptember 10, 2011 at 2:17 pm

Define a “chair.” Then let’s discuss sofas and stools.

The only definition that matters is that current beneficiaries are paid by current investors instead of investment returns.

Such schemes can be so outrageously fraudulent and poorly implemented that they collapse in days or weeks. Other schemes of this type can last for generations when the promised return is less than the capability to raise replacement capital.

SS has no promised rate of return. Returns for many people are negative. It is not only a Ponzi Scheme, it’s a poor investment vehicle. The proof of the pudding is in being forced to participate. Let people opt out, and we’ll see how solvent SS is.

This isnt about “emotion.” It’s about basic finance and economics.

John ThackerSeptember 10, 2011 at 2:52 pm

SS has no promised rate of return. Returns for many people are negative. It is not only a Ponzi Scheme, it’s a poor investment vehicle.

Promised returns are quite positive for people who retired earlier, and quite positive for people who were poor (or who didn’t work many years) but still live a long time. They are poor for people who die earlier and for some people who paid in towards the maximum.

Social Security is not, on whole, a poor investment vehicle. If it were, it would be in long term actuarial balance.

Gibbon1September 10, 2011 at 7:04 pm

You just described an insurance system, in particular payouts are very uneven as you expect with any risk sharing system. If my house doesn’t burn down, all my homeowners premiums are wasted. So? If I die young, I won’t get anything close to what I paid into social security. On the other hand if President Perry mismanages the countries finances and geopolitical relations and ends up causing hyper-inflation, social security might look kind of nice for people whose other investments were wiped out.

Sure in the future all sorts of things can happen that will reduce payouts. But those events would effect investment portfolio’s as well, if not worse.

NicoliSeptember 10, 2011 at 2:11 pm

TGS strikes again….

mwSeptember 10, 2011 at 2:26 pm

boy this is such an important debate for the country to be having–given the massive problems we face and the relative size of contributors to the long-run debt, this one-time 0.7% of GDP social security budget shortfall is definitely where I’d spend my time if I wanted to make an impact on public policy.
on the other hand, justifying the use of socially and emotionally-charged buzz words is a great way to get people who don’t understand the issues riled up to carry around banners denouncing the government for you, to achieve the actual goal of eliminating policies that provide direct help to vulnerable members of society.

John ThackerSeptember 10, 2011 at 2:54 pm

to achieve the actual goal of eliminating policies that provide direct help to vulnerable members of society.

I’m sorry, were we discussing Medicaid or Social Security? The latter program provides direct help to the members of society who are on average the wealthiest, and lots of middle and upper middle class people.

I’m in favor of policies that provide direct help to vulnerable members of society. People like you, who use “socially and emotionally-charged buzz words” “to get people who don’t understand the issues riled up” to carry around banners in favor of welfare for the middle and upper middle class make me sick.

mwSeptember 10, 2011 at 3:59 pm

Why no, of course we’re not discussing medical expenditures. That problem would require creative thinking. Because unlike SS, medical costs are massive, growing components of federal debt (ie: they matter) whose solutions demonstrably demand more than the “government bad, personal responsibility good” mysticism to solve–and we definitely wouldn’t want to take our debate into a regime like that…

One assumes that by “wealthiest” you mean “retired old people are more likely to have accumulated wealth than young people”–of course, how you get from there to “retired old people lacking the income security of the still-employed are not vulnerable” remains, as always, mysterious.

John ThackerSeptember 10, 2011 at 4:14 pm

I’m in favor of programs helping the vulnerable. You’re in favor of shuffling money around to the middle and upper middle class. It’s not that mysterious.

Just keep using buzzwords in favor of sending money to the rich.

mwSeptember 10, 2011 at 4:49 pm

“I’m in favor of programs helping the vulnerable.”

Good to hear. I look forward to your support for lifting the payroll tax cap rather than cutting benefits to close the shortfall.

deariemeSeptember 10, 2011 at 2:28 pm

If it weren’t a Ponzi scheme, the electorate wouldn’t have been so keen on it. Politicians are the citizen’s way of defrauding fellow citizens.

bxgSeptember 10, 2011 at 2:29 pm

> Social Security assets are simply IOUs from the treasury

I think objections about the accounting or economic status of the trust fund (is that what you mean by SS “assets”?) generally confuse the SS conversation more than help. I think such quibbles _support_ the common misapprehension that there is a fund at least trying collect and invest our contributions for the future, in the same sense as a private sector program must try to accumulate assets to fund its obligations. It makes it seem as though the big concern is SS worriers is an – actually fairly estoteric – accounting/economic complaint about what is actually _in_ the trust fund. This implicitly concedes the great significance of the trust fund concept, whereas even were it made of solid gold it’s a rather second-order issue.

FWIW I think Yglesias’s argument ultimately fails because he’s ignoring that there are nuances in how entrenched a law can be. The workers and voters of 2050 can decide to pay less in SS benefits if they decide they cannot afford the payment schedule on the books at the time. Yes, it will take a law change, but last time I looked congress meets each year. Even the _moral_ argument against a law change will look weak once it is looked at objectively: the young are not being asked to return or honor an investment (in any conventional sense of “investment”).

To compare this with a “stock market investment”, which he thinks is the same. The big difference is that I “own” my investments and this has real practical consequences in politics. Now “ownership” isn’t some magical word and this is not a categorical distinction: of course the voters of 2050 can likewise pass a confiscatory tax on my stock market investments – maybe not just 100% of my profits but even a large chunk on my original contributions if they want. But this is going to be politically much, much harder for many reasons. It more obviously hurts current workers as well as retirees. There are more real moral objections to it – to begin with, it really would be – as we all understand the word – confiscatory. And I can own property and investments overseas, and even retire there if need be, so even the 2050 median voter was absolutely determined to do this it would be far leakier than a similar determination to cut smaller SS checks.

The only way of agreeing with Yglesias is to claim that ones anticipated SS benefits are now entrenched by society (and will continue to be regarded so) to be “property” owned by you with with an equivalent legal, moral, and practical status as one’s ownership of some stock. I can’t imagine any remotely nuanced view of ownership that would suggest this, but maybe there is … but I think the burden of the argument is on him.

Yglesias explained precisely what he meant — that if you say without qualification that SS is a ponzi scheme then all kinds of things become ponzi schemes.

All the above commentators — and Yglesias — were explaining that SS only works because of dynamics that are similar to those that sustain ponzi schemes until they collapse. But, as they all agree, social security differs from a ponzi scheme — as generally understood — in being sustainable.

What is nuts is to boldly state that social security is a ponzi scheme without any qualification.

John ThackerSeptember 10, 2011 at 2:58 pm

But, as they all agree, social security differs from a ponzi scheme — as generally understood — in being sustainable.

It’s sustainable only by cutting promised benefits by 20%, or by guaranteeing having an ever-increasing number of new participants. When Samuelson wrote, we had an ever-increasing number of young people. Now we don’t. So Social Security was sustainable– until then.

Yes, Social Security can be made sustainable by lowering the benefit formulas until they aren’t lies. But that’s true of any Ponzi scheme.

What is nuts is to boldly state that social security is a ponzi scheme without any qualification.

What is nuts is to boldly state that Social Security is not a ponzi scheme without any qualification, like “it’s sustainable so long as we cut promised benefits by 20% when the trust fund runs out.”

CarelessSeptember 20, 2011 at 4:24 pm

In 2010 Social Security suffered the same problem that brought Madoff down. Unfortunately for Madoff, he couldn’t paper over that with other sources of revenue.

No, it is not sustainable as it currently is.

vorpalSeptember 10, 2011 at 2:58 pm

I find this conversation to be insipid. People pay into Social Security and they _immediately_ get benefits in return. They immediately get coverage in the case they become disabled. In general, people know precisely how much they pay, and they know exactly what they will receive in return. Moreover, they also know the exact status of the Trust fund at all times. This is nothing like a Ponzi scheme, in the true sense of the word…and anybody who’s taken freshman economics should be able to discern the difference.

The greater concern is that Congress decides to nullify (by an act of law) intra-governmental loans lent by the Social Security trust fund, to other government agencies. In this case, Social Security would become a slush fund, but not a Ponzi scheme. There is reason to be concerned about this because Congressional members regularly refer to Social Security outlays as government spending and part of the “budget.” SS outlays are _not_ spending, they do not consume any resources, like on-budget outlays do. The Social Security Agency runs on federal spending, but not the checks they send out.

John ThackerSeptember 10, 2011 at 2:59 pm

and anybody who’s taken freshman economics should be able to discern the difference.

You can defend the idea that it’s not exactly a Ponzi scheme, but “nothing like a Ponzi scheme,” even “in the true sense of the word” is splitting hairs far more than the people who call it a Ponzi scheme are.

vorpalSeptember 10, 2011 at 3:22 pm

Yeah, one thing being fraudulent and another not being fraudulent is “splitting hairs.” Savvy financial wizard you are.

Social Security is fraudulent. It promises impossible returns. It can be changed to make it possible, but it is unsustainable.

A lie is a lie, and the impossible is the impossible, even if the government says otherwise.

That goes for Social Security as much as it goes for war and the existence of WMDs.

vorpalSeptember 10, 2011 at 4:32 pm

No, it doesn’t “promise” impossible returns. It states pretty clearly what those returns are expected to be. The trustees represent the state of the fund as accurately as they can. What can be expected, given current finances and current law, is completely in public view.

Do you even know what “deceitful” means? Or do you just think that “fraud” is a “bad word” and you consider Social Security to be “bad” and therefore it is “fraud” ? Do I have to explain the flaw in that line of thought?

Deceit is a red herring. Ponzi schemes fail regardless of whether their authors intended to deceive.

If the initial promises made by SS had been accurate, they wouldn’t have had to keep raising the tax. But they made some extremely bad actuarial assumptions about the rate of payment growth vs revenue growth– just as in a Ponzi scheme, their promises to make payments could not be fulfilled with the revenues available.

John ThackerSeptember 10, 2011 at 3:03 pm

The Ponzi-like aspects are now over and social security is turning into what is essentially a forced savings/welfare program with, as Krugman recognizes, crummy returns for average workers. Social security is thus a Ponzi scheme which has not gone bust but it has gone flat.

But the SSA and its formula still promises impossible returns. It’s just that all the papers– and even their own analyses and the CBO’s– assume that after the Trust Fund runs out we’ll suddenly slash benefits by 20%. That to me is incredibly nuts, the idea of suddenly cutting benefits by that much.

vorpalSeptember 10, 2011 at 3:20 pm

It doesn’t “promise” impossible returns. It can’t. By law, it can only spend the money that it has.

BTW: even after a 20% “slash” benefits would still be better than they are now, in real terms. Plus the amount of money needed to make up for this is a very small amount of GDP. So, your “concern” lacks merit.

E. BarandiaranSeptember 10, 2011 at 3:04 pm

Indeed this is another stupid discussion prompted by the mercenary media to attack Perry. It doesn’t matter whether SS is a Ponzi scheme or not –perhaps some people may have fun searching for a Clintonesque definition of a Ponzi scheme to fit or not fit SS. The present SS system matters to the extent that either the promised benefits will have to be cut or taxes will have to be increased to pay for the promised benefits. Once again, the history of Argentina’s SS system is a good reference to understand what will happen with the U.S. system. In Argentina, the 1958 system collapsed much earlier because the huge benefits that were promised (much better than those of the U.S. system) and because tax revenue was diverted to (and wasted in) other uses.

There is nothing fraudulent about Social Security. It is a transparent trust that, by law, must regularly describe its fiscal status to the public. To say that Social Security is a Ponzi scheme is to say that it has fraudulent aspects. It does not.

If you stop paying taxes, do men with guns show up and do violence to you? Try it out if you don’t think so.

I don’t oppose taxation — far from it, I regard taxes as quite necessary — but I don’t confuse them with being voluntary.

vorpalSeptember 10, 2011 at 4:15 pm

It’s not fraud because it doesn’t misrepresent itself. Ultimately, all transactions are backed up by govt agents, so saying there is an enforcement agency speaks nothing to the nature of the program.

John ThackerSeptember 10, 2011 at 4:17 pm

It misrepresents itself. It promises returns that are impossible by current law. The program must be changed.

vorpalSeptember 10, 2011 at 5:06 pm

I would like to see this “promise.” Can you point me to it? Plz, not heresay, but the actual promise itself? I would like to read what I am promised.

claytonSeptember 11, 2011 at 4:14 am

JTFC vorpal. Have you worked enough so you get a statement from the SSA saying when you retire you will get $X per month until you die? Maybe you can point to the asterisk where it states “unless the Trust has enough funds”.

A better question might be “Is the global financial system a Ponzi scheme?”

John ThackerSeptember 10, 2011 at 4:19 pm

Really, you think that’s interesting, vorpal? The global financial system has international agreements like Basel II and has US law backing it. Therefore, by your definition, it cannot possibly be a Ponzi scheme.

Even if it all collapses, our government will just bail out the rich banks and raise the necessary money through taxation. And you, of course, have no problem with that nor find in that anything fraudulent or anything that could call it a Ponzi scheme.

It’s the only logical conclusion from your comments on Social Security.

vorpalSeptember 10, 2011 at 4:52 pm

Just because there are agreements and a legal framework, doesn’t mean that it has transparency. Right now there are gobs of foreclosures that can’t be enacted because nobody can document who owns what.

You see, the difference is in the quality of the information. It’s an abstract concept, I know, but a really important one.

The banking industry has fought against transparency, in particular the mortgage securities industry and the derivatives market. This would make it a legalised Ponzi scheme (if you view it as a Ponzi scheme). The Ponzi part is not in legality/illegality, it is in the quality of the information regarding the financial state of the investments, and the representation of the state of the financial state. A Ponzi scheme needs deliberate deceitful misrepresentation of this information… like giving subprime mortage securities AAA ratings , etc.

If the entire industry conspires to mislead the public into believing it’s investment instruments are something they are not, then we have the beginnings of fraud.

John ThackerSeptember 10, 2011 at 4:20 pm

Me, I’m willing to criticize the global financial system. I just don’t see how vorpal possibly can, since the US government and other governments back it, make it legal, and are willing to use taxation to keep it afloat. That must mean that it’s not a fraud, according to vorpal.

circular reasoningSeptember 11, 2011 at 4:18 am

it’s interesting to see how people like bill and vorpal try to spin an argument and create a reasoning. they’re way off base but always manage to throw something in just in time. very interesting, they’d have made for very good defenders of the church back in the middle ages.

I’ve always assumed SS was a Ponzi-like scheme, but perhaps we are assuming that SS is something other than what it actually is. SS wasn’t meant to be an annuity per se; it was meant to be social insurance. You pay a certain amount of money out of your paycheck and you get a certain amount back after a certain age until your death. In a weird way, it is insurance against(?) long life.

Given that people expect to live past the retirement age, SS is viewed as an annuity with outputs > inputs – a loose definition of Ponzi scheme. *But*, SS would instead seem to a federally subsidized insurance policy.

vorpalSeptember 10, 2011 at 4:36 pm

Like I said before, you get benefits immediately, protection in the case that you are disabled. For millions of people, this benefit is a reality. Some unfortunate people didn’t have to “wait until retirement.”

bxgSeptember 10, 2011 at 4:27 pm

>they also know the exact status of the Trust fund at all times

Certainly, but let me remind “them” just in case “they” don’t know where to look it up.. If you are on SS now, the trust fund can pay your benefits for a bit over four more years. Retired this year at 66? Great, you can know that the trust fund has money for you for a while not one penny for you after you are 70. More than four years before retirement: the trust fund has nothing, not one penny, nada, at all for you. My numbers are rough but you entirely right that the status of the trust fund is both publically and exactly knownable: but it boils down to, about 4 more years payment for current retirees, nothing for anyone else, end of story.

It’s really great to know exactly where we stand!

vorpalSeptember 10, 2011 at 4:40 pm

Yeah, I guess I’ll take your calculations over those of the Social Security trustees report. What do those actuaries know compared to your back-of-the-envelope calculation anyway?

bxgSeptember 10, 2011 at 7:16 pm

I’m sorry. I’m not basing this on back of the envelope calculations, but on public disclosures by the trustees.
You should be able to find the following from their data:

(a) how much do we need to pay out every year, today, to fulful current obligations?
(b) how large is the SS trust fund (?)

Wrt (b), be very clear I’m not calling the trust fund into question in any way (I know many people do). Treat the SS valuation as 100% correct and unquestionable.

Please call us back when you have he ratio (a)/(b) according to the SS admins'; own numbers.

And when you find the answer, and see that I am right by official figures, please answer this: if I am worried about my SS benefits, exactly how relevant or useful it is to me to know the current trust fund value? I mean this somewhat neutrally: be you for or against SS (I am definitely FOR) tell me how the average citizen is supposed to be either reassured or depressed by the current value of a relatively small (in relation to SS obligation) _buffer_ fund. Maybe it’s a big buffer fund. Maybe it’s small. Question remains.

bxgSeptember 10, 2011 at 7:40 pm

I suspect I’m unclear by being too cynical.

Let me try more constructively. The most important, by far, issue for SS sustainability is SS incomings vs outgoings. The trust fund can help us through some bit of time if the latter is less than the former, but in the medium-to-long term it’s largely irrelevant: if we have a huge mismatch between what younger workers are willing to transfer to retirees it falls apart – only the trust fund can save us, and it cant’ do so for very long.
I claim that it’s near-to-useless to anyone to know the size of the trust fund. Yes, it’s a big number. But incomings and outgoings are way bigger. If I tell a person 10-yr away from retirement that current SS assets are, say, 2.5T$, how should this reassure or depress them. Please explain your answer. With _additional_ assumptions yes, this becomes useful, but you will find that the additional assumptions needed are so much more significant, more problematic, that no one sensible would spend much time arguing about whether the trust fund is 1 or 2 or 3 or 4 T$.

vorpalSeptember 10, 2011 at 11:30 pm

The fund can completely meet outlays under current law to past 2030.

Sometime after 2030, benefits _might_ fall short of what they are expected to be by a very small percent of GDP. In other words, the shortfall is well into the future, hypothetical, and easily remedied if it occurs.

Ponzi schemes are none of the above. They quickly fall apart, and do so catastrophically. Social Security is nothing like a Ponzi scheme. To say so, is nuts.

bxgSeptember 10, 2011 at 4:39 pm

> Moreover, they also know the exact status of the Trust fund at all times.

This is precisely as useful as knowing Madoff’s current checking account over the last decade. I’m sure it was real, with a totally reputable bank, and it’s reasonable to guess that at any given point of time it likely contained several million dollars (so many ingoings and outgoings it would need a buffer of somewhat that much). And this would have not been the tiniest bit indistinguishable from a real (non-Ponzi) investment scheme. Knowing what is in trust fund is _mostly_ analagous to this.
There are reasons to feel comfortable about SS, but anyone who looks at the trust fund balance and is comfortable because of _that_ does not have the foggiest how SS works.

Brian DonohueSeptember 10, 2011 at 4:43 pm

Since the tax rate was increased to 12.4% in the early 1980s, Social Security is not a Ponzi scheme. Minor modifications (increasing Normal Retirement to age 70) make the program actuarially sustainable over the long-term.

This assumes, of course, that Social Security is repaid the $2.4 trillion borrowed and used on other government expenditures over the past 25 years.

Medicare, OTOH…

vorpalSeptember 10, 2011 at 5:03 pm

You should check out Dean Baker’s deficit calculator, where it shows what our deficit would be if medical costs were similar to that of other (healthier) industrialised nations. It’s an eye opener.

Brian DonohueSeptember 10, 2011 at 5:14 pm

and furthermore, on the issue of the Social Security Trust Fund, this is a debt owed by taxpayers (who have enjoyed $2.4 trillion in lower taxes over the past 25 years than they otherwise would have faced) to those who have paid Social Security taxes and stand to collect benefits.

Almost everyone considers these groups to be identical, but the group of general taxpayers includes most state and government employees, federal employees hired before 1983, and taxes on “unearned” income, such as trust fund babies. All of these groups have been subsidized by those covered by Social Security for decades.

Social Security is the retirement plan for private-sector workers, and it has been raided unconscionably for decades. I never hear this point of view mentioned.

A Ponzi scheme is a pyramid finance structure. Someone puts money in today, which is spent inmediately and he has to hope that the government still hast the coercitive power to take the money from someone else 30 or 40 years later. By any definition, that is a Ponzi. It is based on huge suppositions and meanwhile clientele politicians from many backgrounds use it as a Pony show to gather votes.

vorpalSeptember 10, 2011 at 5:00 pm

“Someone puts money in today, which is spent inmediately”

Isn’t this called “investing” ? All investing is a Ponzi scheme?

“hope that the government still hast the coercitive power to take the money from someone else 30 or 40 years later”

Yeah, what are the chances of that happening? We all know there will be a worldwide shortage of handcuffs by then.

ricardoSeptember 10, 2011 at 5:37 pm

‘…”isn’t this called investing”?’
No.

Gibbon1September 10, 2011 at 7:26 pm

“‘…”isn’t this called investing”?’
No.”

Well there is passive investment where you buy paper and hope the value goes up. And active investing where you spend money on stuff in that hopes that whatever it is will return a profit. for instance my current employer paying my salary in the hopes that the product I’m working on will sell for a handy profit. Part of the problem we have here is in thinking about investment, the tail (passive investment) is wagging the dog (active investment). And now we have people trying to analyze social security as if it were a mutual fund. This is deranged and ridiculous.

D. Nigel HayesSeptember 10, 2011 at 4:58 pm

Of course it’s a Ponzi scheme. Follow each dollar. The money I put in doesn’t go toward a productive purpose, with the expectation of a return of principal and interest. That’s how it would work if it were actual saving. The money instead goes to another saver who is now ready to collect, and gives him his above-normal returns. That is exactly how Madoff and all other Ponzi schemers pull it off. The only difference is that they advertise the scheme based on those returns, and lie about where the returns are coming from. Look, huge returns! And then the money runs out.

exactly!September 11, 2011 at 4:25 am

short, precise and to the point. great comment!

BillSeptember 10, 2011 at 5:00 pm

This post doesn’t merit a discussion since you do not know what a ponzi scheme is.

This is from the historian of the social security system, available on their website:

“The Logic of Pay-As-You-Go Systems

In contrast to a Ponzi scheme, dependent upon an unsustainable progression, a common financial arrangement is the so-called “pay-as-you-go” system. Some private pension systems, as well as Social Security, have used this design. A pay-as-you-go system can be visualized as a pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end.

There is a superficial analogy between pyramid or Ponzi schemes and pay-as-you-go programs in that in both money from later participants goes to pay the benefits of earlier participants. But that is where the similarity ends. A pay-as-you-go system can be visualized as a simple pipeline, with money from current contributors coming in the front end and money to current beneficiaries paid out the back end.

So we could image that at any given time there might be, say, 40 million people receiving benefits at the back end of the pipeline; and as long as we had 40 million people paying taxes in the front end of the pipe, the program could be sustained forever. It does not require a doubling of participants every time a payment is made to a current beneficiary, or a geometric increase in the number of participants. (There does not have to be precisely the same number of workers and beneficiaries at a given time–there just needs to be a fairly stable relationship between the two.) As long as the amount of money coming in the front end of the pipe maintains a rough balance with the money paid out, the system can continue forever. There is no unsustainable progression driving the mechanism of a pay-as-you-go pension system and so it is not a pyramid or Ponzi scheme.

In this context, it would be most accurate to describe Social Security as a transfer payment–transferring income from the generation of workers to the generation of retirees–with the promise that when current workers retiree, there will be another generation of workers behind them who will be the source of their Social Security retirement payments. So you could say that Social Security is a transfer payment, but it is not a pyramid scheme. There is a huge difference between the two, and only a superficial similarity.

If the demographics of the population were stable, then a pay-as-you-go system would not have demographically-driven financing ups and downs and no thoughtful person would be tempted to compare it to a Ponzi arrangement. However, since population demographics tend to rise and fall, the balance in pay-as-you-go systems tends to rise and fall as well. During periods when more new participants are entering the system than are receiving benefits there tends to be a surplus in funding (as in the early years of Social Security). During periods when beneficiaries are growing faster than new entrants (as will happen when the baby boomers retire), there tends to be a deficit. This vulnerability to demographic ups and downs is one of the problems with pay-as-you-go financing. But this problem has nothing to do with Ponzi schemes, or any other fraudulent form of financing, it is simply the nature of pay-as-you-go systems.

The Start-Up Problem In Pension Programs

There is one other aspect of Social Security, and many private pension systems, that sometimes leads people to a mistaken analogy with Ponzi schemes, and that is the “bonus” paid to early participants in a pension system.

During the start-up of a new pension system the money paid to early participants is usually much in excess of their contributions and higher than the “return” to later participants. This is because people who are nearing the end of their working career will not have an opportunity to participate in the pension system long enough to accrue a significant benefit if computed strictly on an actuarial basis. There are three options: exclude such people from the system; leave them with an inadequate pension; or provide some kind of subsidy to early participants beyond what is justified by their contributions. In private pensions this differential is usually made up by subsidies from the employer. In public pensions this differential is funded by assessing higher taxes than would otherwise be necessary to pay a level benefit to all participants and using these additional taxes to pay higher benefits to early participants.

The first recipient of monthly Social Security payments was Ida May Fuller. Miss Fuller worked for about three years under the new Social Security program and paid $24.75 in payroll taxes. Her first Social Security check in January 1940 was for $22.54–she almost got her money back in her very first payment. Miss Fuller lived to be 100 years old and collected more than $22,000 in benefits.

This type of “bonus” to early participants should not be confused with the mechanics of pyramid schemes. This type of benefit to early participants in a pension system has nothing to do with an investment scheme using Ponzi-like progressions to show false returns to early participants. In private pensions this bonus is simply an expression of the employer’s beneficence. In public pensions it is an expression of public policy. In the context of the early years of the Social Security program it was an expression of a public policy which held that workers already old should not be turned away penniless. This spirit of public generosity has nothing to do with Ponzi schemes.

Ponzi vs. Social Security

Social Security is and always has been either a “pay-as-you-go” system or one that was partially advance-funded. Its structure, logic, and mode of operation have nothing in common with Ponzi schemes or chain letters or pyramid schemes.

The first modern social insurance program began in Germany in 1889 and has been in continuous operation for more than 100 years. The American Social Security system has been in continuous successful operation since 1935. Charles Ponzi’s scheme lasted barely 200 days.”

I was messing with you. Somebody (you) finally had the sense to check the SSA website.

NateSeptember 11, 2011 at 2:54 am

It seems that this argument could be boiled down to, “Pay-as-you-go isn’t a Ponzi scheme because it works.” Well, any ponzi scheme could be made to work if the entirety of the working population were forced to participate, and the amount they were forced to invest continuously rose over time to reflect the increased difficulty in paying the promised benefits. Charles Ponzi might well have become very successful if he’d been able to just point guns at people and make them invest in his scheme against their will!

But a Ponzi scheme just is a “pay as you go” scheme dressed up as an investment — that is, dressed up as a scheme in which you can expect to get out more than you pay in. The fraud lies in the “dressing up” — the point, in other words, is not how such schemes actually operate, but rather how they present themselves to their participants. And that’s the question to ask of SS — does it present itself as a form of investment or as merely a form of forced savings/redistribution?

That’s one kind of Ponzi scheme (it’s what Madoff did, for instance), in which the manager simply lies about returns and pays withdrawals with new investment.

But a Ponzi scheme can also be run honestly and transparently, with the rules known to all — and they still fail when the scheme cannot attract enough new investment.

Is it pyramidal? Well, it has gone from supporting 1 person with the income of 10 to supporting 2 people with the income of 3. It’s not one guy at the top getting rich, but it’s certainly screwing the later partipants.

Abelard LindseySeptember 10, 2011 at 5:26 pm

A ponzi scheme is defined as that which earlier investors are paid by the money paid into the system by later investors. If social security is run like a regular pension fund, with its own fund where the money paid into the fund is invested and returned to the pensionees when they retire, then social security would not be a ponzi scheme. However, if people received money out of social security without even having paid into the system when it was first set up in the 1930’s, then it is a ponzi scheme. Also, if there is no separate fund, and the retirees are paid by the working people paying into the fund, then it is also a ponzi scheme. A third test of whether it is a ponzi scheme or not is if it is legal for private funds to be established and managed in the same manner as social security.

Social security meets all three definitions of being a ponzi scheme. Therefor it is a ponzi scheme.

BillSeptember 10, 2011 at 7:06 pm

So, I am paying for my great grandfather’s social security. Big deal.

vorpalSeptember 10, 2011 at 11:21 pm

Social Security is not just a retirement fund, it is also an insurance fund. It is social security in case of inability to work or decreased ability to earn. So people are getting benefits immediatel .. as they pay. It isn’t pay now, get something later, they are getting something now. So you are misrepresenting Social Security,.

The other stuff you say is just stuff you made up. Social Security is not an investment instrument. It is an insurance program. The metaphor between the two is only that, a metaphor.

RoySeptember 10, 2011 at 5:39 pm

So what if I say that SS is really a protection racket disguised as ponzi scheme…

MartinSeptember 10, 2011 at 5:44 pm

Apparently, Mr. Obama’s nick is “vorpal”.

E. BarandiaranSeptember 10, 2011 at 6:12 pm

Wrong. It’s Solyndra’s (Very) Green Friend as explained in this quasi-Ponzi game link

Alex, you are too sanguine to suggest that the American scheme has now only gone “flat”, not “bust”. In the next few years, approximately 2017, it will take on the characteristics of a “bust” as the liabilities sky-rocket while there is basically no way to pay except through more and more borrowings – at precisely the time when US can least afford to borrow even more.

The US model needs a TOTAL re-design, with elimination of the old-age pension component entirely.

I like it how posters can get away with saying, “I don’t agree with stupid things other people say” and then post what they say and disclaim it as not their own:

Like Alex, when he says: “Of these, I agree the most with Krugman. Social Security is not necessarily a Ponzi scheme but it only generated massive returns in the past because of its Ponzi-like aspects. The Ponzi-like aspects are now over and social security is turning into what is essentially a forced savings/welfare program with, as Krugman recognizes, crummy returns for average workers. Social security is thus a Ponzi scheme which has not gone bust but it has gone flat.”

So, here is my take on and rewrite of this post:

Let’s see how many uniformed people I can find in my pool of readers. Let me disclaim what they say so that I don’t get associated with it, as I still want to retain my reputation among economists. Then let me call something, like, stupid-like, er, I’m sorry, ponzi-like, so I can drive traffic and disclaim responsibility for calling it a ponzi, as I would look stupid to other economists if I said it was, but will not look stupid to my audience because they like red meat.

BillSeptember 10, 2011 at 7:56 pm

Funny, I just looked up what Thoma and de Long were saying about this. Thoma quotes SSA on ponzi definitions, and deLong does a discourse as follows:

“Adeimantos: I have been off in Europe for a while. Why are Tyler Cowen Alex Tabarrok and Greg Mankiw so eager this week to call Social Security a “Ponzi Scheme”?

Glaukon: Perhaps it is because they think Social Security is going to go spectacularly bankrupt?

Adeimantos: I hardly think that the Commissioner of Social Security will be hauled off to jail like Charles Ponzi was on August 12, 1920, with a general announcement that nobody is going to get any Social Security benefits.

Glaukon: But perhaps they believe it will?

Thrasymakhos: No. Neither Greg nor Tyler Alex believes that someday Social Security will have the sudden catastrophic collapse that ends a Ponzi Scheme.

Adeimantos: So they call it is a Ponzi Scheme. But Ponzi Schemes end in a sudden catastrophic collapse, and Social Security will not–that it is a different kind of Ponzi Scheme?

Thrasymakhos: Yes.

Glaukon: Are there any other aspects in which Cowen Tabarrok and Mankiw think that Social Security is different from your usual Ponzi Scheme?

Thrasymakhos: Yes. Because a Ponzi scheme is destined to end in a sudden catastrophic collapse it is fundamentally fraudulent. Since Tyler Cowen Alex Tabarrok and Greg Mankiw don’t see it ending in a sudden catastrophic collapse thy don’t see it as fundamentally fraudulent.

Kephalos: So they think that Social Security is a Ponzi Scheme–but that, unlike other Ponzi Schemes, it is not fundamentally fraudulent and, unlike other Ponzi Schemes, it is not destined to end in a sudden catastrophic collapse?

Thrasymakhos: Exactly.

Kephalos: So it’s like saying that something is salt–although without the sodium and the chlorine.

Adeimantos: Wait a minute. They also claim that Paul Samuelson and Paul Krugman call Social Security a Ponzi Scheme…

Thrasymakhos: Look at the first sentence Tyler Cowen Alex Tabarrok quotes from Samuelson: “Social Security is a Ponzi Scheme that Works”. Samuelson is trying to grab his readers’ attention with the arresting claim that there is a key difference between Social Security and a Ponzi Scheme: Ponzi Schemes don’t work, while Social Security does.

Glaukon: Oh.

Thrasymakhos: And go look at the actual article from Paul Krugman that Tyler Cowen Alex Tabarrok quotes. Paul doesn’t say that Social Security is a Ponzi Scheme. He said that over its first seventy-five years it:

turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over, thanks to changing demographics…

Thus, Paul says, Social Security had a “Ponzi game aspect”–a non-fraudulent, sustainable one–as America’s population aged, but that it no longer has a Ponzi game aspect. To claim that this article shows Paul Krugman “recognizes the Ponzi-like nature of Social Security” would seem to me to be a no-no.

Adeimantos: And Milton Friedman?

Glaukon: You will note that Milton Friedman says that it is a pay-as-you-go system, which “supporters call ‘a compact between the generations’ and opponents call a Ponzi scheme”. If I had to characterize Friedman, I would say that Friedman thinks Social Security is a pay-as-you-go system, and that the Social Security Trust Fund is a “confidence game to convince the public that what the Social Security Administration calls a social insurance program is equivalent to private insurance”. He doesn’t want to be out there calling it a Ponzi Scheme: that’s something that “opponents say”.

Kephalos: So the impression I get is that Tyler Cowen Alex Tabarrok and Greg Mankiw–and Milton Friedman, Paul Krugman, and Paul Samuelson for that matter–think that Social Security is a pay-as-you-go social insurance system, which is not a Ponzi Scheme.

Thrasymakhos: Because he thinks hat it is fundamentally fraudulent and catastrophically unsustainable.

Glaukon: So when Rick Perry says “Social Security is a Ponzi Scheme” he means the normal old-fashioned fraudulent kind destined to collapse. And when Cohen and Mankiw say “Social Security is a Ponzi Scheme” they mean that it is some new kind of Ponzi Scheme that is not fraudulent and not destined to collapse?

Thrasymakhos: Exactly.

Adeimantos: But they convey the impression that they agree with Perry. Why?

Thrasymakhos: That’s because they want to back Rick Perry up.

Glaukon: Why? Is it just because they are playing for Team Republican?”

So basically the entire *USG* is a Ponzi scheme which, when it’s currency loses full faith and credit, will fall under its own weight and leave those who previously paid into the system without much to show. SS is just one small sliver of this entire scheme.

Oddly, DeLong elides the most salient question in this Socratic dialogue: why doesn’t Social Security collapse?

And the answer, of course, is that government, unlike private entities, can simply force everyone to pay more.

So in essence, DBL’s argument is that Social Security is not a Ponzi scheme because it is impossible for a gov’t program to be a Ponzi scheme, even if it has exactly the same problem of revenues being insufficient to make payments. This might be technically true under that definition, but it totally evades the basic criticism that revenues are not sufficient to make payments for later investors and is thus fairly meaningless as a rebuttal.

But I wouldn’t expect anything better from the guy who says if you’re a Republican, you have no honor and should apologize the to country, and who does not allow criticism on his blog. Sad, really, he’s a bright guy but unable to examine his assumptions or grant those who disagree with him the possibility of good intentions. I hope he is one day able to evolve to someone better.

Guest # 7September 10, 2011 at 9:05 pm

If it’s not a Ponzi scheme, ask for the money you paid in to be returned to you because you have decided you want out.it’s not only a Ponzi Scheme, it’s the government forcing you to buy retirement insurance.

MikeSeptember 11, 2011 at 2:59 am

Exactly. There are Ponzi schemes that are voluntary to those who don’t do their due diligence and those which are mandatory even for those who have done so.

Not retirement insurance, but an annuity after retirement. But it’s not an annuity that any profit-seeking firm would make; it never has been. It is just another form of subsidization and malinvestment that will be sustainable as long as the government has control over the money spigot. It’s not a Ponzi scheme in the sense that there is a crash just over the horizon, but that doesn’t make it any better.

DonSeptember 10, 2011 at 10:14 pm

Ponzi Schemes I’ve Known:

Heaven
Amway – MLM
The Cubs
The Jets (forget 1969: even Madoff paid off somebody)
LIbertarianism (living off denouncing socialism while preaching the opposite)
Socialism (living off etc etc)
Crunches (no six-pack abs yet, sigh)
Marriage (depending on inputs/prenups)
401K (being for the benefit of the mutual fund community)
and…
Having children (are they really going to call or visit?)

SS is fuzzy headed like the phrase “paying it forward” but remember, folks, we are a species, not a one-off.

superflatSeptember 10, 2011 at 10:55 pm

this is funny. SS is clearly a pyramid scheme — you pay in, but not for your own direct benefit, or as an investment, and hope later members pay in enough for the pay out to you, and there simply is nothing going on beyond payments in and payments out (that is, there are no investments of any sort) — which is why SS is in trouble (there aren’t enough people entering the pyramid to keep payments up for those who get out). anyone disputing whether SS is a pyramid/ponzi scheme is just playing games. don’t feed the trolls, whether credentialed economists, bloggers, or whatnot.

BillSeptember 10, 2011 at 11:03 pm

superflat, Do you know what a pyramid scheme is?

superflatSeptember 10, 2011 at 11:29 pm

bill, enough folk have done enough explaining that you’ve got no need to mess with me, too, we’re just going to have to agree to disagree on this one. if, however, you want to try to play king of the hill because i didn’t bother to distinguish between pyramid and ponzi much (one has a hub under some definitions, etc.), please, feel free to think you’re smarter than you are (and that i’m dumber than i am). btw, i love that you thought citing a schiller lecture meant anything (appeal to authority is one of the lamest rhetorical gambits). enjoy your further foolishness (which i’m sure will be forthcoming, but apologies if you have the good sense to shut up now).

vorpalSeptember 10, 2011 at 11:40 pm

Pyramid schemes, when they fail (and they always do), fail catastrophically. No disinterested authority has ever stated that Social Security will fail catastrophically. They say it is good for a long time (past 2030) and past that there is a real change that it _may_ not have the funds to pay expected benefits under current law, but it will be able to pay (in real dollars) better than it does even now. Hardly catastrophic.

So pyramids always fail catastrophically (usually sooner than later). Social Security may not fail at all and certainly won’t have any problems for nearly two decades. If it does fall short, it will be by a modest and easily remedied amount.

So, if you think that these two things are the “same”, I don’t think I’ll be taking your investment advice any time soon.

Andrew'September 11, 2011 at 3:22 pm

Of course SS is a Ponzi scheme. What requires that Ponzi’s fail catastrophically? Nothing. They fail because people figure them out and pull their money out, just like how banks fail, because banks can take on aspects of a Ponzi scheme, as they of course did a few years ago.

superflatSeptember 11, 2011 at 9:40 pm

silly point — the only reason SS can’t fail catastrophically is because of the coercion (everyone has to pay in now, regardless of whether they’ll ever get a payout later. and you’re quibbling over the details when the key point — new entrants pay for the exiting entrants, without any other investment, revenue stream, etc. — is indisputable, and indisputably like just about every ponzi/pyramid scheme. what i don’t get is why people fight this point. just say it’s a desirable ponzie/pyramid scheme and be done with it (the people who get out of ponzi/pyramid schemes with great returns are generally pretty happy, if we had enough people, we could all get out, it’s just that darned decreasing birth rate coupled with increasing longevity).

Does George Mason have the highest concentration of Koch funded cranks on the planet? Got to play for team Republican. So lemme get this straight the United States government has a risk profile like a Wendy Gramm Enron scheme, another team Republican looting. Republicans and their crank economists are like Fleischmann and Pons. You can’t stand up to peer review. You are a set of cranks. Those flows through social security are not destined to collapse and they are not fraudulent.

mikeVASeptember 11, 2011 at 12:39 am

Isn’t Wendy Gramm next door with the Koch dollars? I would ask her about schemes and crimes and about playing judges.

guest22September 11, 2011 at 12:54 pm

Vorpal,

You are not entirely correct about SS disability insurance being available right away. A person needs to work a certain number of years, depending on their age, before being able to apply for disability payments. Check out this link:

Doesn’t transparency mark a clear distinction? This, in effect, is why a Ponzi Scheme is fraudulent, but SS isn’t. There is no intent to deceive with SS; the mechanisms are available for inspection (although admittedly difficult to grok in its entirety for some).

bxgSeptember 11, 2011 at 2:54 pm

@vorpal: The fund can completely meet outlays under current law to past 2030.

No it can’t, not even at all close, not by a factor of about 5 or so. Why do you say this? Why don’t you look on the SS trustees report? Can you point us to what on earth makes you say somethings so counter-to-public fact?

(Your statement is true _if_ one defines “completely” as “hardly at all, but then again if we assume that in addition to the trust fund we are allowed to also consider continued incomings of vast sums of new money from younger contributors over this period, that in total dwarf the trust fund many many times over”. In this sense I believe you. With similar latitude I also believe my son’s piggy bank has “completely” covered all SS outlays from about 1980 to 2009 – he should get a medal!)

Andrew'September 11, 2011 at 3:23 pm

Of course Matt is wrong and SS is obviously a Ponzi scheme. But he is getting warmer with his title:

“Social Security Is No More A Ponzi Scheme Than Is Anything Else That Relies On Future Economic Growth”

OK, here’s a simple gedanken: set up a private version of SS with the same rules, the same actuarial assumptions, at the same time SS was established.

Now, fast-forward to 2011. Please explain how the fund can be solvent.

I don’t think there can be any question that if SS had been set up privately under the same rules, it would have failed. Later investors would not have agreed to lower returns, and when the actuarial mistakes became apparent, the fund would have collapsed, and the authors would likely have faced criminal charges.

Andrew'September 12, 2011 at 10:05 am

This is why scale is not a retort to a Ponzi structure. Just because the government is big enough to force payment does not mean that the payments come from productivity rather than pass-through new investors.

Payments certainly don’t come from the ‘lawk bocks’ that invests in Treasurys that are used to largely…you got it…pay current recipients.